Sterling strength not Brexit-related

Trevor Greetham

23 January 2018

Sterling has strengthened to $1.40 for the first time since 2016’s EU referendum, with some attributing this to progress on Brexit talks. However, sterling’s strength versus the dollar reflects broad-based weakness in the US currency. Sterling remains at a relatively low level versus the euro (chart 1).

Until recently all of the big moves in sterling since the referendum could be explained by changes in interest rate expectations. The vote to leave the EU was bad for sterling because an increase in economic uncertainty meant the Bank of England was unlikely to raise base rates significantly for years to come. Based on this relationship, you would expect sterling strength linked to progress in Brexit talks to go hand in hand, with an increase in UK interest rate expectations relative to the US.

In fact, the reverse has happened. The dollar has weakened despite an increase in US interest rate expectations (chart 2). This poses the risk of a snap back in the dollar and a sudden drop in the pound that commentators would no doubt blame on Brexit setbacks.

Chart 1:

Sterling has strengthened to $1.40 for the first time since 2016’s EU referendum, with some attributing this to progress on Brexit talks. However, sterling’s strength versus the dollar reflects broad-based weakness in the US currency. Sterling remains at a relatively low level versus the euro (chart 1).

Until recently all of the big moves in sterling since the referendum could be explained by changes in interest rate expectations. The vote to leave the EU was bad for sterling because an increase in economic uncertainty meant the Bank of England was unlikely to raise base rates significantly for years to come. Based on this relationship, you would expect sterling strength linked to progress in Brexit talks to go hand in hand, with an increase in UK interest rate expectations relative to the US.

In fact, the reverse has happened. The dollar has weakened despite an increase in US interest rate expectations (chart 2). This poses the risk of a snap back in the dollar and a sudden drop in the pound that commentators would no doubt blame on Brexit setbacks.

Chart 1:

Chart 2:

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.